Friday, June 10, 2016

Good Deflation Is Good

Except, maybe, for debtors who have to run faster to stay in place on their payments.
From Ed Yardeni's Dr. Ed blog:

Why are the major central banks so paranoid about deflation? It’s
probably because they are staffed (stuffed) with macroeconomists who
associate deflation with depression. In their opinion, falling prices
make it harder for debtors to service their debts. Widespread defaults
on those debts could cause a financial crisis and a severe economic
downturn. I believe their thinking is that simplistic.

Yet, perversely, the central banks have been responding to the risk of
deflation with ultra-easy monetary policies in an effort to stimulate
more debt-financed spending. It seems to be working in the US, though a
significant portion of borrowing in recent years has been in the
corporate bond market to finance stock buybacks. More recently,
debt-financed M&A activity has picked up as well. Often, these deals
are associated with cuts in payrolls.

On the other hand, debt is financing a US boom in multifamily housing
construction and solid activity in commercial real estate.
Mortgage-financed new and existing home sales also have continued to
recover from the Great Recession. Auto loans are financing cyclical
highs in auto sales.

US consumer price inflation measures excluding food and energy are
closer to 2% than to zero. So the Fed is more relaxed about deflation
and started raising interest rates again at the end of last year.
However, Fed officials constantly and consistently say that the process
of normalizing monetary policy will be very gradual.

In the Eurozone and Japan, both headline and core consumer inflation
rates are close to zero, i.e., bordering on deflation. Ultra-easy money
has failed to stimulate borrowing and demand in their economies. Both
have been in growth recessions over the past few years. Since Q4-2010,
real GDP is up 10.5% in the US but only 3.2% in the Eurozone and 2.7% in
Japan.

The Chinese authorities don’t have a deflation problem as measured by
their CPI. They do have one as measured by their PPI, which has been
falling on a y/y basis for the past 51 months through May. They have
been all too successful at pumping lots of credit through their banking
system in the economy. Perversely, rather than fueling demand, much of
it has financed more deflationary capacity expansion. China actually
stands out as the one country where deflationary pressures may very well
lead to lots of debt defaults and a severe downturn. However, easy
money is exacerbating the problem rather than ameliorating it. Let’s
dive into the widely feared sea of deflation and see what we can see:

(1) Durables deflation. There are seven countries that report the
durable goods, nondurable goods, and services components of their CPIs.
Here is what they’ve done since 1996:

The pattern is obvious: There has been across-the-board deflation in
durable goods, while nondurable goods and services have continued to
inflate almost everywhere. The only difference recently (i.e., since
mid-2014) is that energy prices have contributed deflationary pressures
to the nondurable goods components. Durable goods deflation has been
mostly good deflation, attributable to big gains in manufacturing
productivity thanks to technological innovations. Weak demand hasn’t
been the source of the deflation. On the contrary, durable goods
deflation certainly has benefitted consumers around the world, lifting
their purchasing power and standards of living....